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Idiosyncratic risk and the equity premium: evidence from the Consumer Expenditure Survey

  • Timothy Cogley

This paper uses household consumption data to investigate whether uninsurable idiosyncratic risk accounts for the equity premium. The analysis complements and extends prior empirical work by relaxing maintained assumptions about idiosyncratic income shocks. Following Mankiw (1986), the paper develops an equilibrium factor model in which risk premia depend on the covariance between an asset's return and certain moments of the cross-sectional distribution for consumption growth. Cross-sectional consumption factors are constructed using data from the Consumer Expenditure Survey, but they do not appear to be promising candidates for explaining the equity premium. Cross-sectional factors are very weakly correlated with stock returns, and generate equity premia of 1.5 percent or less when preference parameters are set at plausible values.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 98-07.

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Date of creation: 1998
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Handle: RePEc:fip:fedfap:98-07
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  1. John H. Cochrane & Lars Peter Hansen, 1992. "Asset Pricing Explorations for Macroeconomics," NBER Working Papers 4088, National Bureau of Economic Research, Inc.
  2. Sumru Altug & Robert A. Miller, 1987. "Household choices in equilibrium," Working Papers 341, Federal Reserve Bank of Minneapolis.
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  4. Mankiw, N.G. & Zeldes, S.P., 1990. "The Consumption Of Stockholders And Non-Stockholders," Weiss Center Working Papers 23-90, Wharton School - Weiss Center for International Financial Research.
  5. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  6. N. Gregory Mankiw, 1986. "The Equity Premium and the Concentration of Aggregate Shocks," NBER Working Papers 1788, National Bureau of Economic Research, Inc.
  7. Deaton, Angus & Paxson, Christina, 1994. "Intertemporal Choice and Inequality," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 437-67, June.
  8. Stephen Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 24-85, Wharton School Rodney L. White Center for Financial Research.
  9. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  10. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  11. Daniel, Kent & Marshall, David, 1997. "Equity-Premium And Risk-Free-Rate Puzzles At Long Horizons," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 452-484, June.
  12. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 928-56, October.
  13. Orazio Attanasio & James Banks & Sarah Tanner, 1998. "Asset Holding and Consumption Volatility," NBER Working Papers 6567, National Bureau of Economic Research, Inc.
  14. Orazio P. Attanasio & Guglielmo Weber, 1994. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," NBER Working Papers 4795, National Bureau of Economic Research, Inc.
  15. Nelson, Julie A, 1994. "On Testing for Full Insurance Using Consumer Expenditure Survey Data: Comment," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 384-94, April.
  16. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June.
  17. Attanasio, Orazio & Davis, Steven J, 1996. "Relative Wage Movements and the Distribution of Consumption," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1227-62, December.
  18. Kocherlakota, Narayana R, 1990. " Disentangling the Coefficient of Relative Risk Aversion from the Elasticity of Intertemporal Substitution: An Irrelevance Result," Journal of Finance, American Finance Association, vol. 45(1), pages 175-90, March.
  19. Hall, Robert E & Mishkin, Frederic S, 1982. "The Sensitivity of Consumption to Transitory Income: Estimates from Panel Data on Households," Econometrica, Econometric Society, vol. 50(2), pages 461-81, March.
  20. Duffie, Darrell & Huang, Chi-fu, 1986. "Multiperiod security markets with differential information : Martingales and resolution times," Journal of Mathematical Economics, Elsevier, vol. 15(3), pages 283-303, June.
  21. Haliassos, Michael & Bertaut, Carol C, 1995. "Why Do So Few Hold Stocks?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1110-29, September.
  22. Lucas, Deborah J., 1994. "Asset pricing with undiversifiable income risk and short sales constraints: Deepening the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 325-341, December.
  23. Kent D. Daniel & David A. Marshall, 1998. "Consumption-based modeling of long-horizon returns," Working Paper Series WP-98-18, Federal Reserve Bank of Chicago.
  24. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-76, October.
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